INSOLVENCY

Question 1

INSOLVENCY OF SOLE PROPRIETORS
AND PARTNERS—BANKRUPTCY

Answer 1

. If the sole proprietor or a partner can no longer pay debts when they become due, they have several voluntary options, including, 1
1. negotiating with creditors,
2. entering an individual voluntary arrangement, or
3. applying for bankruptcy. Alternatively, a creditor may pres-ent a creditor’s petition for bankruptcy, forcing the debtor
into bankruptcy if certain criteria are met.

Question 2

Negotiating with Creditors

Answer 2

1.An individual or partner who owes more money than they
can pay (the debtor) can approach a creditor and ask either
for the debt to be reduced or for extra time to repay the debt.
2. However, typically such an agreement is not bind-
ing on the creditor, as there is no contract consideration giv-
en by the debtor to support the creditor’s promise to abide
by the change in terms. Therefore, at any point the creditor could demand the full amount on the original payment terms.

Question 3

Individual Voluntary Arrangement

Answer 3

1. An individual voluntary arrangement (‘IVA’) is a negotiated
   agreement between the debtor and all of their creditors.
   The creditors each agree to accept less in payment than is
   owed them.
2. Procedure
   (1) A debtor who wants to agree an IVA with their creditors
   must take professional advice; the debtor cannot proceed
   alone. The debtor must fnd an insolvency practitioner (that is, someone who is licensed to act on behalf of companies or individuals facing insolvency). The insolvency practitioner will draw up proposals and supervise the implementation of the IVA.
   (2) Statement of Affairs and Application for Interim Order

(3) meeting of creditors

(4) Implementation of plan

Question 4

Statement of Affairs and Application for Interim Order
IVA

Answer 4

The insolvency practitioner will have the debtor prepare
a statement of afairs and will apply to the bankruptcy
court for an interim order. Whilst this order is in force, no
bankruptcy petition may be presented or proceeded with
unless permission to proceed is granted by the court.
Additionally, no other proceedings or executions can be
commenced against the debtor. This gives the insolven-
cy practitioner a breathing space to try to work out what
assets and liabilities the debtor has, and whether there
is any likelihood of a successful IVA, without individual
creditors sending in the bailifs and whittling away the
available assets.

Question 5

meeting of creditors
IVA

Answer 5

1. The insolvency practitioner prepares a report advising
   whether there are any realistic proposals to ofer to the
   creditors and whether it is worth calling a meeting of
   creditors. If a meeting is called and at least 75% in value
   of the debtor’s unsecured creditors agree to the prac-
   titioner’s proposals, the proposals become binding on
   every ordinary unsecured creditor who has notice of the
   meeting, even if they did not attend or vote.
2. Preferential creditors (that is, employees owed holiday
   pay or wages due in the last four months) and secured
   creditors (creditors who have taken collateral to protect
   their debt) are not bound, unless they agree to the pro-
   posal.

Question 6

Implementation of Plan

Answer 6

The insolvency practitioner (now called a supervisor)
oversees and implements the proposals. If the debtor
fails to comply with the IVA or provided false or mislead-
ing information, the supervisor or any creditor who is a
party to the IVA may petition for the debtor’s bankruptcy.

Question 7

Bankruptcy Definition

Answer 7

1.Bankruptcy is a judicial process in which the assets of the
bankrupt debtor are passed to a third party, the trustee in
bankruptcy, who liquidates the assets and uses the money
from the liquidation to pay of as many of the debtor’s debts as possible in a strict order set out by legislation.
2.Once an application for bankruptcy is made, the debtor’s creditors must stop chasing after the debtor, and the debtor will be
discharged from most of their debts after one year.

Question 8

Procedure
An application for a bankruptcy order can be made in three ways:

Answer 8

*The debtor can apply online to declare themself bank-rupt. The application is heard by an adjudicator appoint-
ed by the Secretary of State. The application will be
granted if the adjudicator fnds the debtor is unable to
pay their debts;
*One or more unsecured creditors who is/are owed at
least £5,000 combined can present a petition for an
order of bankruptcy to the bankruptcy court; or
*The supervisor of an IVA can petition for the debtor’s
bankruptcy if the debtor has breached the terms of the
IVA, hidden assets, or given a preference to a creditor.

Question 9

ofcial receiver

Answer 9

If the bankruptcy order is made, then an ofcial receiver is
appointed. The ofcial receiver is a civil servant who will act as the trustee in bankruptcy unless the creditors seek to
appoint their own nominee.

Question 10

Creditor’s Application
Bankrupcy

Answer 10

1.A creditor who applies to have the debtor declared
bankrupt must prove that the debtor is insolvent (un-
able to pay their debts) by showing either that the debt
is payable immediately and the debtor does not have
funds to pay, or the debt is payable in the future and the
debtor has no reasonable prospect of being able to pay.

2. The creditor may use the following methods to make the
   necessary showing:
   *If the debtor owes a liquidated debt for £5,000 or more, the creditor may make a statutory demand for payment; if the debt is not paid within three weeks, or the debtor does not apply to set aside the statu-tory demand within three weeks, the debtor will be deemed insolven
   *If the debtor owes a future liability of more than
   £5,000, the creditor may serve a statutory demand
   for proof of ability to pay; if the debtor does not show
   a reasonable prospect of being able to pay the debt
   when it falls due or apply to court to set aside the
   statutory demand, the debtor will be deemed insol-
   vent.
   *If the debtor owes a judgment debt of more than
   £5,000, the creditor can seek to execute on the judg-
   ment; if the attempt fails, the debtor will be deemed
   insolvent.

Question 11

Bankruptcy Estate

Answer 11

The bankrupt’s estate vests automatically in the trustee in
bankruptcy. This means the bankrupt does not need to go
through any legal formalities to transfer those assets. There
is no need for them to complete a stock transfer form or the
like.

Question 12

Exemption from the Bankruptcy Estate

Answer 12

1. The bankrupt is entitled to keep some assets needed for
   day-to-day living, such as furniture and any tools required
   for their job.
2. The bankrupt is also entitled to retain any salary
   they make, subject to the trustee applying for an income
   payments order, if the salary exceeds the amount needed for the reasonable needs of the bankrupt and their family.
   3.The **payments order can last for a maximum of three years.

Question 13

Bankrupt’s Home

Answer 13

The bankrupt’s interest in their home will pass to the
trustee, but there may be other legal or equitable interests in the home:
*The home could be held in joint names;
*A partner/spouse may have an equitable interest arising from a trust
*A spouse may have a right of occupation under legis-
lation; or
*Children under 18 may live in the home, giving the bankrupt and their spouse/partner a right of occupa-tion.
If there are any of the above interests in the home, the
trustee cannot sell the home without a court order, and
the court will consider all the interests before making an
order for sale. However, after one year, the interests of
the creditors are paramount, and so will take precedence
over any of the other people claiming an interest.

Question 14

Restrictions on Debtor
During bankruptcy, in order to protect creditors, the bankrupt is restricted from certain behaviour. For example, the bank-
rupt may not:

Answer 14

*Apply for credit of more than a prescribed amount;
*Act as a company director;
*Be a partner; or
*Trade under another name without disclosure of the
bankruptcy.

Question 15

Order of Priority for Distribution to Creditors
The order of priority for distribution to creditors for a bank-
rupt is:

Answer 15

1) Costs of the bankruptcy;
2) Preferential debts (that is, holiday pay due to employees
and wages of employees due in the last four months and
HMRC in respect of VAT, PAYE, and National Insurance contri-butions owed);
3) Ordinary unsecured creditors; and
4) Postponed creditors (spouse or civil partner).
If there is not enough money to fully satisfy all the creditors at one level, then the debts rank and abate equally. This means all the creditors in that category will receive the same per-
centage of their original debt.

Question 16

End of Bankruptcy

Answer 16

If the bankrupt complies with the restrictions and has not
caused the bankruptcy by their own dishonesty, negligence, or recklessness, then the bankruptcy will be automatically
discharged after one year.**

Question 17

Culpable Bankrupts

Answer 17

A bankrupt who has caused the bankruptcy by their own dis-honesty, negligence, or recklessness is considered ‘culpable’ and can be subject to a court bankruptcy order for up to 15 years.

Question 18

What If an Individual Who Is a Partner Is Made
Bankrupt?

Answer 18

1. Partnership at will
2. partnership not at will
3. limited liability partnership

Question 19

Partnership at will

Answer 19

1. If the bankrupt person is a partner and the partnership
   is a general partnership at will, then,, the partnership will be dissolved on the bankruptcy of the partner.
2. The trustee in bank-
   ruptcy (or liquidator if the insolvent partner is a company) will receive any money due to the insolvent partner, to be used for the beneft of the partner’s creditors.
3. A partnership at will arises if a partnership is formed for an indefinite term and there is no agreement preventing individual partners dissolving the partnership.

Question 20

partnership not at will

Answer 20

1. If the bankrupt person is a partner and the general part-
   nership agreement provides that the partnership will not
   terminate on bankruptcy of a partner, then the partner-
   ship will continue and,
   2.usually the remaining partners will purchase the insolvent partner’s interest from the trustee
   in bankruptcy (or liquidator if the insolvent partner is a
   company), in accordance with the retirement provisions
   in the partnership agreement.

Question 21

Limited Liability Partnership

Answer 21

An undischarged bankrupt cannot be a member or take
part in the management of an LLP without the agreement
of the court. The trustee in bankruptcy will seek to realise
the member’s interest for the beneft of his creditors, usu-
ally by selling the interest to the remaining members in
accordance with the retirement provisions in the partner-
ship agreement.

Question 22

If** a general partnership** is insolvent, the partnership is wound up using the same processes as for bankruptcy, if it is comprised of individuals, or for liquidating a limited company, if
it is comprised of companies, or both if it is a mixture. The
ofcial receiver or insolvency practitioner will:

Answer 22

*Make sure all contracts are completed, transferred, or
otherwise ended;
*Cease the business;
*Settle any legal disputes;
*Sell any assets;
*Collect money owed to the partners or partnership; and
*Distribute any funds to the creditors.

Question 23

What If an LLP Is Insolvent?

Answer 23

If an LLP were to be made the subject of a winding-up order, it would be administered by the ofcial receiver as a limited company, as discussed below.

Question 24

Insolvency Options for Companies
The options available for companies are:

Answer 24

*Receivership: This enables secured creditors to recover
what is owed solely to them
*Restructuring plan: This allows companies to restructure
their debts with the sanction of the court;
*Moratorium: This halts most actions by creditors to en-
force their rights;
*Administration and company voluntary arrangements:
These seek to rescue the company; and
*Liquidation: This causes the company’s assets to be sold
to pay of debts and the company will cease to exist.

Question 25

Fixed Asset Receivership

Answer 25

When a
company borrows money, a creditor may take security over
the company’s fxed assets, such as its equipment or plant.
The loan and security agreement between the company and
the creditor will set out what comprises a breach. It will usu-
ally also give the lender the right to appoint an administrative receiver if the company commits a breach. In the case of a
breach, the receiver takes possession of the asset securing
the loan (the ‘charged asset’) and (usually) sells it to pay the
secured lender (the sale is not for the beneft of all the cred-
itors). Once the asset is sold, the receiver has no further role
in the company.

Question 26

Restructuring Plan

Answer 26

1. A company or LLP that has encountered or that expects
   fnancial difculties may propose a compromise or ar-
   rangements with its creditors or members. Usually, the plan
   involves the creditors agreeing to accept less than they are
   owed but more than they would likely receive in bankruptcy.
2. The plan must be approved by those owed at least 75% in
   value of the unsecured debt.
3. The court may approve the
   plan even if one or more classes disagrees with it and the
   dissenting creditors will be bound (known as** a cram down)**.

Question 27

Moratorium

Answer 27

1. A company in fnancial distress may seek a moratorium which prevents creditors from taking action to enforce their fnan-
   cial rights or from commencing formal insolvency proceed-
   ings during the moratorium. (payment holiday)
2. Purpose
   The purpose is to rescue the company as a going concern
   and return it to proftable trading through a Company Volun-tary Arrangement (see below), a restructuring plan, refnanc-ing, or an injection of new funding. A moratorium is not a
   formal insolvency procedure.
3. Procedure
   The directors of the company will appoint an insolvency
   practitioner as ‘monitor’ to oversee the company’s afairs
   and ensure that it is likely that the moratorium will result in a rescue of the company as a going concern.

*To obtain the moratorium, the directors and the monitor
fle certain papers with the court.

*The directors remain in charge of running the business.

*A moratorium is not available for companies which are, or
have within the previous 12 months been, subject to an
insolvency procedure.

Question 28

Administration

Answer 28

Administration is a procedure which enables the administra-
tor (an independent insolvency practitioner) to run, reorgan-
ise, and/or sell the company as a going concern. This might
enable the company to avoid going into liquidation. The aim
of administration is for the administrator to (in order of impor-tance):
*Rescue the company as a going concern;
*Achieve a better result for the company’s creditors than
would be achieved if the company were to be wound up;
or
*Realise property to distribute to one or more secured
creditors.
The administrator acts in the interests of the creditors as a whole (unlike the receiver, above, who only acts for one secured creditor).

Question 29

procedure of administration

Answer 29

A company can go into administration by two methods:
*Through a formal court hearing; or
*By the company, its directors, or the holder of a quali-
fying foating charge fling certain documents with the
court.

If the court appointment is used, then the court can make the order only if it is satisfed the company is unable to pay its
debts and that the order is likely to achieve a better result
for the company’s creditors than liquidation. The directors
and the company (the members) can appoint an adminis-
trator if no winding up petition has been issued. They must
notify any qualifying foating charge holder who will agree or appoint an alternative administrator.

Question 30

Qualifying Floating Charge

Answer 30

A qualifying foating charge is a charge over the whole or
substantially the whole of the company’s assets. It will con-
tain a provision empowering the lender to appoint an admin-
istrator or an administrative receiver if a breach has occurred which allows the lender to enforce its security under the
terms of the credit agreement (usually this is non-payment of
interest or capital).

Question 30

Role of Administrator

Answer 30

1. The administrator must be a licensed insolvency practitioner. 2. They have the power to take control of the company’s prop-
   erty and sell it, bring or defend legal proceedings on behalf
   of the company, carry out the company’s business, remove or replace directors, and so on.
2. The administrator also has the
   power to investigate previous transactions of the company to seek to increase the value of the assets for the creditors and
3. can take action against the directors for wrongful and fraud-
   ulent trading.

Question 31

Moratorium Is Imposed to Restrict Other Insolvency Procedures under Administration

Answer 31

An advantage of administration is that a moratorium is im-
posed which: (i) restricts the ability of third parties to enforce
their rights, and (ii) prevents the commencement of other
insolvency procedures, giving the administrator breathing
space to try to achieve the sale of the company as a going
concern.

Question 32

Company Voluntary Arrangement

Answer 32

1. A Company Voluntary Arrangement (‘CVA’) is similar to an
   IVA; it is a compromise between the company and its cred-
   itors under which each creditor usually agrees to take less
   than the full debt owed them.
2. It is used when the company
   has a short-term cash fow problem but is generally fnan-
   cially sound.
3. Although the creditors might not be paid in full, they are likely to receive more money than if the company
   went into liquidation.

Question 33

Process for a CVA

Answer 33

1. The process is started by the directors of the company
   who make a written proposal to the creditors and nominate an insolvency practitioner to supervise the CVA.
2. As with an IVA, 75% or more in value of the unsecured creditors
   must agree to the CVA in order for it to be implemented.
   3.Ifthe CVA fails, the company could still end up in liquidation
   (discussed below) oradministration (discussed above).
3. As with an IVA, at least for small companies, it is possible to
   have a moratorium which restricts the ability of third parties to enforce their rights and prevents the commencement of other insolvency procedures which can give the company a breathing space.

Question 34

Voluntary Liquidation

Answer 34

There are two kinds of voluntary liquidation–members’ and creditors’.

Question 35

Members’ VoluntaryLiquidation

Answer 35

1. In a Members’ Voluntary Liquidation (‘MVL’), the
   members and directors control the process from start to fnish.
2. **It is available only if the company is solvent, but the individuals involved in run-
   ning the company wish to wind it up

Question 36

Creditors’ Voluntary Liquidation

Answer 36

A Creditors’ Voluntary Liquidation (‘CVL’) is started by the
directors but then taken over by the creditors. Although it is
voluntary, it will usually be commenced because the directors
are advised that the company is insolvent and if they continue trading, they could be personally liable for the debts
of the company through fraudulent or wrongful trading.

Question 37

Compulsory Liquidation of Company

Answer 37

A creditor who can show that the company is unable to pay
its debts can petition for the company to be wound up.

Question 38

Role of Liquidator
in Compulsory Liquidation

Answer 38

The liquidator collects in the assets of the company and dis-
tributes funds to the creditors in the statutory order and the
company is dissolved.

Question 39

Order of Priority for Distribution to Creditors
The liquidator must pay back the creditors of the company in a set order:

Answer 39

1) Expenses of winding up (the liquidator’s and profes-
sional advisers’ fees);
2) Preferential debts (these are holiday pay due to em-
ployees and wages of employees due in the last four
months (up to a maximum amount), and HMRC in respect
of VAT, PAYE, and National Insurance contributions);
3) Debts secured by foating charges in order of priority
(subject to ring fencing (see below));
4) Unsecured debts; and fnally
5) Shareholders.
If there is not enough money to fully satisfy all the creditors at one level, then the debts rank and abate equally. This means all the creditors in that category will receive the same per-
centage of their original debt.

EXAMPLE
A liquidator has £25,000 remaining to pay unsecured
creditors totalling £100,000. Each creditor will receive
25,000/100,000 of their original debt. This is often referred to as receiving x pence in the pound. Here a creditor would receive 25p for every £1 owed. So, a creditor owed £5,000 would receive £1,250.

Question 40

CLAW BACK OFASSETS

Answer 40

1. The liqui-dator, administrator, or trustee in bankruptcy has a duty to
   the creditors and has powers to investigate the company or
   individual’s actions prior to the insolvency to maximise the
   funds available and to ask the court to set aside transactions that violate law, including the transactions discussed below.
2. PREFERENCE
3. TRANSACTION AT UNDER VALUE
4. Fraudulent trading
5. wrongful trading
6. setting aside a floating charge

Question 41

Preferences

Answer 41

A preference arises when a debtor does something that puts a creditor, surety, or guarantor in a better position on liquida-tion or administration than they would have been if the event had not occurred.

Question 42

Preference Must Have Been Intentional

Answer 42

For the event to be a preference, the company or individual must have desired to prefer the creditor, surety, or guarantor of the company. However, the desire to prefer is presumed
if the preference is in favour of a connected person (such as a director, their spouse, or other close family member or an
associate of the bankrupt).

Question 43

Within Six Months

Answer 43

1. For an event to constitute a preference, it must have oc-
   curred within six months of the onset of insolvency (two
   years if the preference was made to a connected person or associate of the bankrupt).
2. For a company compulsory liquidation, the onset of insol-
   vency is the date of presentation of the petition.
3. For a CVL, it is the date the company enters liquidation.
4. For administration, it is the date the company fles a No-
   tice of Intention to Appoint an Administrator or the date
   when it enters administration, whichever is earliest.
   5.For an individual, it is the presentation of the bankruptcy
   petition.

Question 44

CONSEQUENCE OF PREFERENCE

Answer 44

The transaction will be voidable at the discretion of the court. The court can order that any property be returned, any pro-
ceeds of sale be returned, or any security discharged

Question 45

Transactions at an Undervalue

Answer 45

A transaction at an undervalue arises when property that
would have otherwise been part of the bankruptcy estate
was given as a gift or was sold for signifcantly less than mar-ket value within two years of a company’s insolvency or fve
years of an individual’s bankruptcy. The consequences of an undervalue transaction are the same as those for a prefer-
ence**

Question 46

Insolvency Requirement
For a transaction to be set aside (or otherwise remedied) as
an undervalue transaction:

Answer 46

(1) for a company, it must have
been insolvent at the time of the transaction or become so
as a result, but there is a presumption of insolvency if the
transaction is to a connected person. (2) For an individual,
there is no requirement to prove the debtor was insolvent at
the time the transaction was made if it was made within two
years before the petition, but insolvency is presumed if the
transaction was made at any time in favour of a close relative or business associate.

Question 47

Defence of Undervalue Transaction

Answer 47

For a company, there is a defence if the transaction was
entered into in good faith, for the purpose of carrying on
the business, and when it was made there were reasonable
grounds for believing it would beneft the company.

Question 48

Granting Security Not Undervalue

Answer 48

Granting a security interest in a company asset is not con-
sidered to be a transaction at an undervalue as this does not change the value of the company’s assets, and so does not
reduce their value. However, as discussed above, the grant
can give rise to a preference which may be set aside.

Question 49

Fraudulent Trading

Answer 49

1. Fraudulent trading arises when a director (or any other per-
   son who knowingly participates) carries on business of the
   company with the intent to defraud creditors.
2. An action can be brought by a liquidator or an administrator.
3. If fraudulent trading is established, the directors may be liable to make such personal contribution to the company’s assets as the court orders. 4. Fraudulent trading is also a criminal ofence.

Question 50

Wrongful Trading

Answer 50

1. Wrongful trading is a claim that at some time before a com-
   pany became insolvent, the directors knew or ought to
   have known that there was no reasonable prospect that the
   company would avoid insolvency and failed to take adequate steps to minimise the losses to the company’s creditors.
2. Once a director knows or ought to know that insolvency is
   unavoidable, their duty shifts from what is best for the share-
   holders to what is best for the creditors. A wrongful trading
   action can be brought by a liquidator or administrator.\
3. If the claim is successful, the court may order the director to con-tribute to the company’s assets as the court deems appropri-ate.

Question 51

defense of wrongful trading

Answer 51

A director can defend the action by showing they took every step with the view to minimising potential loss to the compa-
ny’s creditors after becoming aware that the company had
no prospect of avoiding liquidation

Question 52

Setting Aside a Floating Charge

Answer 52

Floating charges (for example, security interests in a compa-
ny’s inventory, as discussed in the chapter on raising fnance) may be voidable as a preference, as discussed above. But
a foating charge is automatically void—and a liquidator or
administrator need not apply to court for a declaration of
invalidity or an order to set the foating charge aside—if the
foating charge was created:
*For no consideration within 12 months ending with the
onset of insolvency (or two years for a connected per-
son); and
*At a time the company was insolvent or became in-
solvent as a result if the charge was given to a person
unconnected to the company. However, there is no
requirement to show insolvency if the foating charge is
to a connected person.
EXAMPLE
A company has an unsecured overdraft at the bank. The
bank, worried about the company’s cash fow, requires a
foating charge to secure the overdraft. The company goes into liquidation 10 months later. The foating charge will be
invalid and the bank will be an unsecured creditor.
If, however, the bank had agreed to increase the overdraft
limit from £100,000 to £200,000 in return for the foating
charge, and the company’s overdraft was £150,000 on liqui-dation, the foating charge would be valid for the fresh con-sideration but not for the original overdraft. Therefore, the
bank would have a foating charge in respect of £50,000
and would be an unsecured creditor for £100,000.

Question 53

Ring Fencing

Answer 53

A liquidator is required to set aside part of the assets subject to a foating lien for the beneft of unsecured creditors. (The
assets are fguratively ringed by a fence.) The amount is 50% of the frst £10,000 in value of the property subject to foating charges and 20% on amounts above, up to a maximum ring-
fenced fund of £800,000.